Alumina (ASX:AWC) – Quality At An Oversold Price

Today, we’ll look at why we think Alumina Limited stock (ASX:AWC) has good potential upside in our AWC share price forecast and analysis.

Alumina Limited (ASX:AWC) is an Australian company that owns the largest pure-play alumina manufacturer in the world.

The company was recently hit with low margins due to ore quality, high energy prices, delays in mine approvals, and disruption in demand from war among other factors.

However, things are now looking up with clarity on various issues.

AWC is well-placed to shrug off its problems moving forward.

The stock has underperformed the ASX200 by about 38% over the past year and is recovering from being heavily sold off.

About Alumina Limited Stock (ASX:AWC)

Alumina Limited is the largest pure-play alumina maker in the world, accounting for about 9% of total global production.

The company’s sole asset is a joint venture between mining major Alcoa (60%) and Alumina Limited (40%) which owns and operates a network of bauxite mines, alumina refineries, and some investments in aluminum smelters.

The company’s mines and refineries network extends across Australia, Brazil, Guinea, and Spain.

It also owns a stake in joint ventures such as 55% in the Portland Aluminium smelter and 25% with the Kingdom of Saudi Arabia in an ore and refinery complex.

Nearly two-thirds of the company’s production comes from West Australia with the bulk of refining occurring at its Pinjarra and Wagerup refineries, followed by Alumar in Brazil.

These three refineries are world-class assets with the lowest 10% cost structures in the world.

The company produces in the region of 12000 kt of Alumina a year and at the current AWC share price, has a market cap of A$3.09B.

Source – 1H’23 Results Presentation

Solid Asset Base With Positive Developments

Alumina Limited’s (ASX:AWC) biggest strength lies in the strength of its assets and core operations.

The company operates world-class assets with the lowest ex-China capital costs that have first decile (lowest 10%) cost structures and lowest quartile (bottom 25%) emissions intensity per ton.

The company’s recent woes are also showing strong signs of reversal and have resulted in a steep undervaluation of the company.

Source – 1H’23 Results Presentation

There are four core reasons for a likely revival in the company’s fortunes – improved energy costs, closure of unviable refineries, improvement in alumina prices, and development of further mining approvals.

For starters, the company has been facing big headwinds over the past 2 years due to higher energy costs.

In Spain, the San Ciprean refinery in Spain is about to be shut down due to high European gas costs while the Kwinana refinery in Australia was operating at just 70% capacity due to supply disruptions in the Australian gas market.

However, energy costs are now normalizing as the effects of the Ukraine-Russia war are now more subdued economically while natural gas supply has normalized in Australia with enough supply expected to meet all needs in 2024, although supply still faces some long-term issues.

Overall, the impact of energy costs on production is now stabilized as compared to the last two years.

Secondly, the company has decided to shut down its refineries in Kwinana while San Ciprian has been scaled back by 50%.

The company is trying to reach a deal with the Spanish government to shut down San Ciprean due to unavailability and high costs.

The developments will reduce the impact of these unviable operations on the company and put the company among the lowest-cost operators of alumina production in the world.

On the other hand, the cutoff of this supply will also help shore up prices.

Third, the long-term AWC share price (ASX:AWC) outlook is very bullish due to multiple factors.

Based on current prices and expected long-term price consensus, about 5%-10% of global alumina operations are unviable or require curtailments, which should inevitably give way to lower supply and improve prices.

This includes about 8Mt from multiple ex-China producers and about 2Mt from Alumina’s curtailments/shutdowns.

Other factors include a firming up of Chinese demand in 1H’23 that has shut the China Alumina export arbitrage, which exists due to no tax on Alumina exports but a 15% tax on Aluminium exports.

However, a firming of demand has now made it cheaper for users to import ex-China alumina, which is good for AWC’s realizations.

Source – Wood Mackenzie

Further, the Chinese Alumina sector has moved to Guinea bauxite over the last few years due to a net benefit from higher quality.

Higher quality bauxite lowers caustic soda costs.

However, the culmination of high freight costs, lowering energy prices, and a big spread between Australian and Guinea bauxite should revive Australian bauxite and alumina demand.

Lastly, the Alumina and Aluminium price spread is trading well below historical averages and should improve with higher demand.

Improvement in demand looks likely as the global economy has sustained war and a historic rate tightening cycle fairly well, and rate cuts are in sight over 2024.

Fourth, the company has received clarification on environmental concessions for additional mining permits at Myara North and Holyoake.

As these mining areas are around the crucial Serpentine water catchment area, the approval process has been sticky and will serve as a precedent for further approvals.

The concessions involved include a farther radius from water catchment sites which will reduce mining resources a bit and higher rehabilitation costs and requirements.

That being said, timelines aside, this is a positive development as these sites will bring Alumina’s mine resource back to historic levels and end the more quality issues it faces now and will be a positive influence on the AWC share price.

Single Asset Portfolio With Significant Macro Risks A Weakness

The only major weakness Alumina Limited (ASX:AWC) suffers from is a complete reliance on one product.

Its one product portfolio which is produced using volatile inputs exposes it to long periods of low prices due to a variety of reasons such as overproduction from rapid increase in capacity in other regions of the world, energy price shocks, etc.

Further, being a core industrial metal, aluminum (processed alumina) is exposed to heavy price swings from macroeconomic downturns.

While the global economy has largely sustained a rapid rate hike regime, any stumbles before cuts could have a sharp impact on commodity prices.

Energy prices are yet to normalize and are at risk of rising due to tensions in the Middle East and the Suez Canal.

Macroeconomic disruptions could potentially be headwinds to the AWC share price.

Massive Decarbonization Opportunity

The biggest opportunity available to Alumina Limited (ASX:AWC) is leadership in the decarbonization of alumina production, an opportunity towards which the company is taking big strides.

Alumina production involves multiple steps.

First, is digestion using the Bayer process, where bauxite ore is mixed with caustic soda at high temperature using medium-pressure steam (derived from water and natural gas) to dissolve aluminium-bearing components, next is clarification, which purifying the slurry from digestion to separate the caustic solution and impurities.

Next is precipitation in storage dams where raw alumina is precipitated from a caustic solution.

The last stage is called calcination where alumina is washed and dried at high heat to crystallize it.

Most of the energy required and emissions from alumina production are caused in stages 1 and 4, representing roughly 70% and 24%, or 98% of emissions.

Alcoa and Alumina Limited (ASX:AWC) have invested in meaningful R&D to decarbonize both processes and drastically reduce freshwater use, contingent on renewable electricity from solar and wind, however.

They aim to achieve this with a combination of technology they are developing called Mechanical Vapor Recompression and Electric Calcination.

The benefit from this shift is derived in two stages, first steam is generated from renewable energy instead of natural gas and the second is reusing the steam generated in calcination which cannot be recycled into the first step currently due to impurities generated from natural gas combustion.

If natural gas combustion is removed, the water and heat can be reused for serious savings while cutting out nearly all carbon emissions.

Source – MVR Technical Feasibility Study

Feasibility studies show that the use of MVR alone with generate per ton savings of about 16% in capital costs and the figure will be greater after accounting for electric calincation.

Further, the net energy costs of MVR are about half that of natural gas-powered refineries, representing an operating cost saving of 12%-15% per ton of production.

The company is aggressively piloting the technology and is receiving financial incentives from government energy agencies.

This opportunity could be a major upside for the AWC share price, especially for investors focused on ESG.

Execution Risk And Contingencies Are Threats

The major threats faced by Alumina Limited (ASX:AWC) are execution related such as delays in obtaining mine approvals for new capacity, which could be very adversarial for the company as it is already suffering from low-grade ore from old mines.

There is also the added risk of inflationary pressures on capex for mine moves to newer mines post approvals which escalated sharply post-COVID.

Other threats include a long-standing tax dispute in Australia that could result in a penalty of over A$700M (about a year’s EBITDA) and sustained inflationary pressure on indirect costs such as personnel as experienced in 1H’23.

Lastly, a major threat is financial penalties in the form of carbon taxes as climate action grows across the world, if the company cannot successfully transition its production to low carbon over a reasonable timeframe.

These issues combined can be considerable headwinds for the AWC share price.

Alumina Limited (ASX:AWC) Financials

In FY22-23, the company reported revenues of $5.7 billion (up about 9% YoY) and EBITDA of $301 million (down 40% YoY) at the joint venture level owing to lower margins and higher operating expenses.

AWC’s share of PAT stood at $109 million, down 52% YoY from FY21’s $226 million excluding exceptional items and $98.3 million including exceptionals.

In 1HFY23-24, the company reported a net loss of $43 million, down from from a profit of $168 million in 1H’22 owing to production issues from lower bauxite quality and mine issues.

While the company benefitted from lower energy prices, mine quality issues resulted in increased cash cost per ton.

Source – 1H’23 Results Presentation

In 1H’23, the company reported an increase in realized prices to $361 from a low of $343 in 2H’22 owing to higher demand from China and global markets.

However, costs elevated from $319 to $304 due to the issues mentioned above.

It must be noted, however, that costs are much lower at $306 excluding the loss-making San Ciprian plant.

Combined with the closure of Kwinana where costs exceed $400/ton, the company’s cost structure will be lowered to the $250 range, putting it in the first decile of costs across the world.

This would imply a margin of $90 on a consensus long-term realized price of $350, representing an EBIT margin of about 25%.

In the medium term, EBIT margins are expected to be in the $120 range by 2H’24.

The company recently announced the shutdown of its mainstay Kwinana refinery and is in talks with the Spanish government to shut down its San Ciprian refinery which is operating at 50% capacity.

These measures will involve shutdown costs but lower the cost of production and improve prices realized and profits in the medium term.

The cost of these closures and curtailments is expected to be about US$500 million over the next 5 years but will be offset to a meaningful extent due to lower sustaining capex and monetization of outstanding energy purchase agreements.

While there is no clarity on the fate of San Ciprian, Kwinana will save about $70 million a year as its operating cost of production was well over AWC’s realized prices of $361 over 1H’23.

The company currently has a net debt of $221 million and a credit facility of US$500 million.

Its dividend is expected to resume by Q3’25.

The stock had a high dividend payout ratio which was halted over the last couple of years due to subdued prices, high costs, and supply-side disruptions.

On the capex side, FY24 capex is projected at $280 million and the company faces a capex of about $400 million over the next 7 years mainly on account of mine moves to newer mines.

Net debt is projected to peak at $400 million.

For FY23, the company has guided 10.3M tonnes of alumina (down about 13% YoY), and 155 kt from its aluminum smelter JV’s (roughly flat YoY).

The company is expected to swing back to profitability by the end of FY25.

Analysts project NLAT (including exceptionals) of $104 million in FY24 due to one-time costs from plant shutdowns and restructuring.

Profitability is expected to resume by FY25 with an NPAT projection of $136 million.

Note – these are figures based on AWC’s 40% share in the AWAC JV with Alcoa.

Alumina Limited (ASX:AWC) Valuation

Unfortunately, AWC is a mammoth alumina producer with no direct comparable rival.

Most companies in the space are vertically integrated aluminum producers with smelting operations or part of muti-commodity mining portfolios.

AWC is the only pure-play alumina producer of comparable scale available as an individual investment.

However, AWC’s financials make a solid case for bullishness.

Two primary drivers are pointing at AWC’s undervaluation.

Firstly, at the current AWC share price, it is trading at about a 22% discount to its NAV.

NAV is arrived at based on the NPV of its bauxite, alumina, and aluminum smelting JV assets.

Current prices show an assumed long-term price of just over $300/ton while long-term consensus prices point to prices of $350.

Source – Goldman Sachs

Secondly, its world-class asset base is valued far below its replacement costs given that capex intensity for ex-China refineries stands at $1000-$1400/ton of Alumina and $100/ton of bauxite.

Taking a replacement cost analysis points at an implied share value of A$3.25, representing an undervaluation of 64%.

This figure is derived from calculating capex replacement cost at current prices of ex-China capacity/ton multiplied by AWC’s 40% share of total production capacity.

Source – Goldman Sachs

Conclusion

To conclude, Alumina Limited (ASX:AWC) is a world-class alumina producer with a solid market share and a world-class asset base.

The company has made difficult decisions to fix its long-term competitiveness despite short-term consequences and costs.

Alumina has a bright future as aluminum is a key component of decarbonization, a megatrend that will define the next decade.

Further, the company’s other troubles like soft prices, mining approvals, and energy disruptions are all undergoing positive developments.

This combined with its efforts in decarbonization technologies and value in its current price means the AWC share price has good upside potential.